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May 2021 Performance Review

June 3, 2021

The leadership in the market appears to have changed. Large cap growth and tech names are no longer driving the big gains and are even dragging on the market cap weighted indexes as smaller and cheaper stocks catch up, which benefits our current portfolios.

Our Conservative portfolio gained 1.95%, and our Aggressive portfolio gained 2.74%. Benchmark Vanguard funds for May 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 0.69%; Vanguard Total Bond Index (VBMFX), up 0.24%; Vanguard Developed Mkts Index (VTMGX), up 3.63%; Vanguard Emerging Mkts Index (VEIEX), up 1.73%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.64%.

This was one of our best months of relative performance during a positive month for stocks since the early 2000s, when our value and foreign stock and bond focus did well relative to U.S. large cap stocks, even in up markets. As we are generally taking less risk than the market, we beat on the way down by falling less with the aim of boosting our stock allocations at lower levels than of more closely matching the eventual recovery.

The main problem with this catching up phase of formerly underperforming stock categories is that we're fast approaching overvaluation of everything. It is not like anything was particularly cheap to begin with, more just a relative bargain compared to massive, large cap growth stocks. Keep in mind that most companies aren't growing that fast and don't really deserve very high valuations, though in a world of permanent zero rates, the notion of valuations is becoming less important to investors than predicting what people will desire in the future. This recent strong price action is almost alarming with our Vanguard Energy (VDE) holding up over 41.7% for the year and Vanguard Small-Cap Value (VBR) up 24.3%, compared to the S&P 500's more modest 12.7% gain.

Most of our stock funds beat the S&P 500 last month. Even our Nasdaq short fund was up slightly, highlighting the recent troubles of larger growth stocks. We're likely going to have to do another rebalance-oriented trade, cut back somewhat on stocks, and wait it out in cash and bonds. Ideally, interest rates would continue to go up, but even the big move up in rates from the lows of last year has flattened out, and we never even got to 2% on 10-year Treasury bonds. It is too early to tell if our recent buys of longer-term investment grade bonds came too soon, but those buys should offer us downside protection and something to sell to buy more stocks during the next slide.

The problem everywhere is the one we've been battling for years, which appears to get worse with every rebound in the economy and markets—too much money chasing for too few investments.

You can blame the Fed, but the money creation isn't really the direct issue; it's more the support of falling investments leading to investors overpaying for risky assets. The Fed put, so to speak, means that things won't really fall apart too far for too long before the Federal Reserve steps in to support prices till things get better, as we saw in the very troubled bond market last year, early in the pandemic. Minimal support can fix things as the Fed only spent a fraction of the trillions used to buy government debt last year to buy actual corporate debt and, somewhat controversially, distressed bond ETFs.

On top of this monetary crisis support, the government always seems to forget differences and toss money at problems. This leads to risky investments being priced as if there is little long-term risk because... Is there? As long as you are in good company (lots of investors making the same bet, be it in homes, bonds, or stocks) somebody has your back if things get too ugly. This support plus low borrowing costs (and therefore low cash and savings returns) leads to a collective movement—so why not join in, since you have more to lose by not gambling?

The other issue is that wealth grows fast and much of it is invested, not spent. Thomas Piketty laid this out in his 2014 economics bestseller, Capital in the Twenty-First Century. But where does all that growing wealth go? What if the supply of good investments can't keep up? In a world where wealth is taxed at a lower rate than income and wealth grows faster than income, the only natural limiting factor is poor investment opportunities: opportunities that are overpriced, or underwhelming, that can destroy wealth.

This has always been the main self-correcting mechanism to too much money—bad investment ideas. Imagine that we had never had 1929, or the dot com crash, or the housing crash. Wealth needs to be destroyed every so often to keep balance in the universe. You just don't want to be the one holding the bag when we go into wealth destruction mode, be it ever so brief.

The only real risk in such a supported market is relatively short term, the panic that sets in when trouble starts, where many want to get out and wait for the support to start. This selling can lead to cataclysmic drops followed by government action and fast rebounds. It seems that eventually, if these rebounds take us to ever higher valuations, this formula will stop working and we'll blow through the government support back to some level of valuations that more accurately adjusts for the heightened risk of investing. But can that even happen, if the Fed creates money and buys stocks, not just bonds, in a crash?

Living proof that we have too much cash sloshing around is the ongoing cryptocurrency boom. On some level, you could describe the whole affair as manufacturing collectible assets out of thin air to have a place to put all the money. How much more can go into trillion-dollar growth stocks and high-end collectibles like art, anyway?

Back in the short term, in our own portfolios last month, the leaders were Franklin FTSE Brazil (FLBR), up 9.6% as the out of favor, former high flyer of the 2000s, Brazil, may have hit rock bottom, at least to investors looking to time the rebound. Vanguard Energy (VDE) was up 6.55% as oil prices took off during our fast-overheating semi-post-Covid economy. All is not well in the long term in the energy business, as massive global efforts to phase out carbon and reward alternative energy could mean that big oil's best days are behind them. But then, there were good investment returns in cigarette makers well past their heyday, especially after weakness. At least the regulatory overhang is largely known to big oil. Big tech, on the other hand, is still living a largely government-free life as the increasingly obvious monopoly power these companies have has yet to lead to tangible major damage to these businesses—in fact, they are still allowed to buy up competitors more or less at will.

Much of our stock outperformance this month was because of a falling dollar, as can be seen directly in Invesco CurrencyShares Euro (FXE), which effectively owns euros, up 1.31%. Most fund categories were up last month, except for those with growth stocks, which were down 1—2%, typically. Convertible bond funds were down, as they have devolved into growth funds, due to excessive convertible bond issuance by booming tech stocks. Healthcare funds were down slightly, though our VanEck Vectors Pharma. (PPH) fund was up 3.78%.

We had three losers last month. ProShares Decline of Retail (EMTY), our inverse retail fund was down 1.45% as retail remains hot. Vanguard Extended Duration Treasury (EDV), our very long-term government bond fund, was down 0.11%. This fund was recently added back to the portfolio mostly because there is no cheaper way to add reliable protection from the next calamity, though there is risk here if rates take off again. Such a move would likely come with rising stock prices, so we should be fine with offsetting gains. Utility stocks were weak last month, with Vanguard Utilities (VPU) down 2.34%. Utilities are an area we may increase our (recently reacquired) allocation.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)9.60%
Vanguard Energy (VDE)6.55%
Vanguard FTSE Europe (VGK)4.45%
VanEck Vectors Pharma. (PPH)3.78%
Franklin FTSE Germany (FLGR)3.64%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.63%
Vanguard FTSE Developed Mkts. (VEA)3.58%
Vanguard Value Index (VTV)2.92%
Homestead Value Fund (HOVLX)2.57%
Vanguard Small-Cap Value (VBR)2.23%
Franklin FTSE South Korea (FLKR)2.01%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.73%
ProShares UltraShort QQQ (QID)1.51%
Invesco CurrencyShares Euro (FXE)1.31%
[Benchmark] Vanguard 500 Index (VFINX)0.69%
Franklin FTSE China (FLCH)0.40%
ProShares Decline of Retail (EMTY)-1.45%
Vanguard Utilities (VPU)-2.34%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)1.76%
Vanguard S/T Infl. Protect. (VTIP)0.77%
Vanguard Long-Term Bond Index ETF (BLV)0.33%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.24%
Vanguard Extended Duration Treasury (EDV)-0.11%

April 2021 Performance Review

May 5, 2021

It was the best of times, it was the best of times. The only thing that seems capable of burning investors now is just that: too many good times. The S&P 500 was back in the top 10% of the entire universe of over 100 fund categories, and in the top 15% for the year. Our portfolio saw more of our funds underperforming the index as well.

Our Conservative portfolio gained 2.27% and our Aggressive portfolio gained 1.98%. Benchmark Vanguard fund performances for April 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 5.33%; Vanguard Total Bond Index (VBMFX), up 0.95%; Vanguard Developed Mkts Index (VTMGX), up 3.17%; Vanguard Emerging Mkts Index (VEIEX), up 1.86%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.17%.

The S&P's continuing outperformance seems like proof of why the S&P 500 is the best investment, relative to other funds. You will get no beef here about the long-term benefit of low fees and passive management. However, this sort of outperformance is more akin to the experience of the late 1990s, when investors piled into the U.S. growth winners during the years of outperformance. Ultimately this led to a stock market crash, with the S&P 500 underperforming most global fund categories for the next several years.

The end of U.S. large-cap growth and tech dominance may already be here. In that respect, it is just like early 2000. There is no saying what will be the cause of the decline, or just the rotation to other types of stocks (or increasingly — gulp — crypto-collectibles).

Many inflation-oriented fund categories that could benefit from rising inflation had a good month; precious metals, real estate, commodities, and energy partnerships were all near the top of the list. Nothing was down except for Japan funds, India, and surprisingly, energy stock funds such as we now own. However, they are still in the top 3% of fund categories for the year, with returns of over 20%.

Our only real standout was Franklin FTSE Brazil (FLBR), with a 6.46% return. The only loser was Franklin FTSE China (FLCH), down 0.18%. Bond rates drifted down, pushing most bonds up even with the threat of an overheating economy. Our recently re-added Vanguard Extended Duration Treasury (EDV) was up 2.87%, followed by iShares JP Morgan Em. Bond (LEMB), up 1.89%, pushed by a higher risk appetite.

There is certainly fear of missing out on the next leg of the boom as we come out of the Covid lockdown. But optimism can quickly turn. Psychologically, it could just be a fear of losing gains in hot areas, or it could be the temptation of higher-returning speculations beating old winners — trade in the Tesla stock for crypto.

More a fundamental factor than an emotion one to the triggering of a market slide would be the Fed increasing interest rates, to counter the solid boost to an already accelerating economy of another significant stimulus program, if passed. A few years back the Fed did the opposite. The Federal government wasn't doing much deficit spending to boost a still sluggish post-2009 economy, so the Fed did all the heavy lifting — low rates and money creation through so-called quantitative easing or QE. It did the same thing last year, with the extra boost of massive government spending.

Does it make sense to continue to run massive deficits this far into a recovery? An enormous infrastructure plan could be mothballed for the next recession, so they have a ready-to-go (shovel-ready…) jobs and stimulus program, rather than a panic stimulus during a crisis resulting in questionable grants and checks in the mail. If we start an infrastructure stimulus program now, will we have less money to burn when we need it? Will we create more demand for labor and materials in a booming post-Covid economy, and cause increased traffic and energy waste? Why didn't we attend to the infrastructure late in the Covid economic slowdown after the initial hard shutdowns? We already see shortages and price booms in many materials key to growth, and could worsen the problem. Perhaps an on-deck plan doesn't take the nuances of a current crisis, be it real estate or pandemic, but infrastructure seems somewhat perennial.

The current Treasury Secretary and former Chair of the Federal Reserve just slipped, and said aloud that the Fed might have to raise rates to cool the economy in the face of more government spending. The market didn't seem to like it, even though she quickly toned down the message.

The other looming threat to the party is higher taxes. While this future drag is far off, investors' behavior may already be changing in anticipation of significant tax changes. Muni bond yields are at historic lows relative to treasuries, as investors expect even better after-tax returns as rates go up. If favorable capital gains taxes will increase to ordinary income tax levels, which themselves are going up, will investors try to book gains while rates are low? Or will they have to wait, as such changes can be retroactive to the beginning of the year? Perhaps the dumping hour will be late this year, before any actual tax changes are passed with the presumption they are coming in 2022. With such low rates, are large investors using margin loans to avoid booking gains, and will that party end if rates go up? Or will interest rates stay low, with high capital gains rates leading to more extended holding periods — like forever, as investors with significant gains wait for lower rates, years down the road? Perhaps we will get a bigger stock boom, as nobody with capital gains wants to sell and pay 50% taxes on the gains, State and Federal.

The more predictable part is that corporate tax rates will likely climb, which can only lower corporations' after-tax profits, making their current valuations even higher.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)6.46%
[Benchmark] Vanguard 500 Index (VFINX)5.33%
Homestead Value Fund (HOVLX)5.23%
Vanguard FTSE Europe (VGK)4.78%
Vanguard Small-Cap Value (VBR)4.01%
Vanguard Utilities (VPU)3.78%
Franklin FTSE Germany (FLGR)3.56%
Vanguard Value Index (VTV)3.44%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)3.17%
Vanguard FTSE Developed Mkts. (VEA)3.05%
Invesco CurrencyShares Euro (FXE)2.47%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.86%
VanEck Vectors Pharma. (PPH)1.24%
Franklin FTSE South Korea (FLKR)1.23%
Vanguard Energy (VDE)0.43%
Franklin FTSE China (FLCH)-0.18%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)2.87%
iShares JP Morgan Em. Bond (LEMB)1.89%
Vanguard Long-Term Bond Index ETF (BLV)1.82%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.95%
Vanguard S/T Infl. Protect. (VTIP)0.87%

March 2021 Performance Review

April 3, 2021

The stock market moved back up on increasing optimism that the upcoming roaring post-COVID economy is going to lift all boats, and plenty of yachts, too. This wasn't good for bonds, which have been struggling for months now (except for inflation-protected bonds), as the consensus is that inflation is going to take off with interest rates. This move in stocks was mostly US stocks, as the S&P 500 beat 90% of fund categories last month with only a sub-5% return. Technology stocks were weak last month as more value oriented stocks continued to lead this latest stage of the post-COVID crash-booming market.

Our Conservative portfolio gained 0.81%, and our Aggressive portfolio gained 1.90%. Benchmark Vanguard funds for March 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 4.38%; Vanguard Total Bond Index (VBMFX), down 1.38%; Vanguard Developed Mkts Index (VTMGX), up 2.61%; Vanguard Emerging Mkts Index (VEIEX), down 1.03%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.51%.

Considering how relatively lousy foreign stocks and bonds did globally in March, our returns were not too bad, as noted by performance relative to the Vanguard STAR fund benchmark, which was up less than even our Conservative portfolio. We are in no position now to perform well relative to the US market if mega cap US growth stocks return to leading the way and rates keep going higher from these levels. Moreover, higher rates here are helping push up the dollar, along with a relatively good current COVID situation compared to the rest of the world, which could drag on our foreign funds.

Most of our lift was from market beating returns in value-oriented stock funds. Vanguard Utilities (VPU) was up 10.29%, astounding for a relatively conservative utilities fund, as investors are piling into whatever offers good inflation protection and yield. There is also the future story: who is going to power this electric economy? All five of our S&P 500-beating stock funds had solid yields, as did many of the pretty good returners. The drags were from shorting the leading Nasdaq stocks, and our Euro currency fund, both down by single digits. Except for Vanguard S/T Infl. Protect. (VTIP), which was up 0.42%, all of our bond funds were down evern more than the bond index.

Our recent portfolio changes didn't help, as the stocks we cut back on for rebalancing kept going up and inflation-adjusted bonds that we largely sold were flat, while our newly added non-inflation-adjusted bonds sank as rates moved higher. Inflation probably won't live up to current high expectations—it generally never does. The government didn't launch inflation-adjusted bonds to pay more than regular bonds, but to pay less.

The implied inflation rate by 5-year inflation bonds is now 2.55%, meaning you won't beat regular government bonds unless inflation comes in higher than 2.55% on an annualized basis over the period (at least if you purchased the bond directly and held to maturity). This seems unlikely, as the Federal Reserve has more power to stop inflation than possibly at any time in history: simply selling some of the trillions of bonds purchased with new money would quickly cause a deflationary situation to develop. Worse, if we get another economic slide, this inflation expectation will collapse, potentially sending longer term inflation bonds down by double digits. These types of bond funds did terribly during the early Covid crash for this reason (we didn't own them then).

Anything but a booming year could cause problems for the stock market. It is now looking like other countries are going to have continued COVID problems as vaccine rollouts won't be robust, for the twin reasons of lack of supply and lack of demand. Vaccine skepticism is surprisingly high in many countries.

While the recently slowly rising COVID numbers here and more frightening numbers abroad are a concern the underlying boom in speculation is the potentially destabilizing force in the market at this time, not COVID or even government debt in the shorter run.

Investors are high on the market again, in late 1990s style. We're seeing lots of trendy new ETFs launching with overly optimistic ideas of the future of growth and story stocks, and investors are signing up by the billions—just like in 1999. Worse, when not day trading on new apps that gamify stock betting, more are getting sucked into the wonders of cryptocurrencies, because apparently the last 80%+ Bitcoin crash three years ago didn't end this speculative mania for long.

The only question: is this 1999 or 2000? Can it go on for another exciting year (or two) where those questioning these goings-on are labeled "old-fashioned" investors who don't get it?

Could Bitcoin continue an upward move and not just be worth $1.1 trillion dollars as it is now, but $10+ trillion—more than all the gold that has ever been mined over the centuries—as many of the Bitcoin cult predict? Anything is possible with mass hysteria. In many ways gold shouldn't be worth $10+ trillion, either.

If enough people want to place a high value on something, it doesn't actually have to have any fundamentals to be a collectible—just desire. The trouble is in what happens if some want to sell to buy actual things so they can enjoy their newfound crypto coin riches. If more capital goes into crypto coin hording, mining, and related endeavors, and less into supplying goods and services, and all these millions of bitcoin buyers become bitcoin millionaires, who is going to supply the stuff they want to buy? Ultimately this is how a crash happens, and the fear of losing will exceed the fear of missing out.

The total value of all crypto collectibles (they don't deserve the dignity of being called currency or coins) is now just over $1.6 trillion. This was about the value of all subprime mortgage debt in 2007 when the total residential mortgage market was around $15 trillion. This is probably a good relationship to how much over-valuation there is in hot investments today. While the trillion plus in crypto is dangerous, it is really a sign of an entire market that is over-speculated, so to speak. Crypto needs to fall 90%+ and growth stocks including startups need a 50%+ haircut. How much impact such a collapse will have on the economy remains to be seen, but it will ultimately be worse the bigger the boom gets. The housing market—which was saved from a complete depression scenario with ever lower rates and favorable refinance deals backed by the government—reinflated and could itself follow this speculative bubble down when it collapses.

We're about at a point where, if the cryptocurrency bubble gets any bigger, when it does eventually come crashing down it will take the whole economy with it, much like the housing crash a decade ago. If creating an economy around collectible hording was such a great idea, Spain would have remained an empire as a big gold player hundreds of years ago, exploring the world for more shiny wealth, rather than collapsing in bankruptcy multiple times.

The value of collectibles, be they gold, Bitcoin, Beanie Babies, or Van Goghsare a side effect of an economy that grows in wealth from producing goods and services of value, not the cause of growing wealth in the economy.

Stock Funds1mo %
Vanguard Utilities (VPU)10.29%
Vanguard Value Index (VTV)6.65%
Vanguard Small-Cap Value (VBR)5.31%
Homestead Value Fund (HOVLX)5.09%
Franklin FTSE Brazil (FLBR)4.90%
[Benchmark] Vanguard 500 Index (VFINX)4.38%
Franklin FTSE Germany (FLGR)3.82%
Vanguard FTSE Europe (VGK)3.32%
Vanguard Energy (VDE)3.06%
Vanguard FTSE Developed Mkts. (VEA)2.78%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.61%
VanEck Vectors Pharma. (PPH)2.21%
Franklin FTSE South Korea (FLKR)1.66%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.03%
Invesco CurrencyShares Euro Currenc (FXE)-2.89%
ProShares UltraShort QQQ (QID)-5.46%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)0.42%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.38%
iShares JP Morgan Em. Bond (LEMB)-2.56%
Vanguard Long-Term Bond Index ETF (BLV)-3.28%
Vanguard Extended Duration Treasury (EDV)-6.27%

February 2021 Performance Review & Trade Alert

March 4, 2021

February was another good month, for us and for global markets. Many fund categories which have lagged in recent years continue to beat the market. This has benefited our portfolios as we've been moving into these areas in recent years (and paying the price for it, lagging the increasingly tech-dominated market). With a balanced portfolio, we have managed to be in the performance range of the S&P500 while beating the Vanguard Star Fund (VGSTX) by a small margin.

Our Conservative portfolio gained 2.09% and our Aggressive portfolio gained 2.90%. Benchmark Vanguard funds' performances for February 2021 were as follows: Vanguard 500 Index Fund (VFINX), up 2.76%; Vanguard Total Bond Index (VBMFX), down 1.51%; Vanguard Developed Mkts Index (VTMGX), up 2.52%; Vanguard Emerging Mkts Index (VEIEX), up 1.65%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 1.87%.

Last month the top fund categories were energy, small cap value, natural resources, value in general, and many foreign markets. These hot returns boosted our overall performance, even with relatively low stock allocations compared to what we have in a bargain market. Vanguard Energy (VDE) was up 22.45% as everyone is suddenly sure that inflation and a booming economy are around the corner. Vanguard Small-Cap Value (VBR) was up 8.79%, mostly because value is coming back and small cap has lagged. It wasn't all roses, as Franklin FTSE Brazil (FLBR) was down 6.37% after some hot months. Vanguard Utilities (VPU) was down 5.54% as rates rose significantly.

The temptation is to sit back and let the dollars roll in. We should be somewhat insulated from the next slide in stocks, which will probably be in whatever sector was hottest over the last few years (sort of like 2000 and 2007). This could happen, but in all likelihood most stocks will drop when this market deflates eventually. There are many signs that the stock market is due for a slide, and not only from high valuations. High prices aren't a perfect indicator; in a boom, a large part of the gains happen in its last phase, and nobody wants to leave the party early. As noted before, low interest rates can support very high valuations because the alternative is bleak and debt financing can boost all assets.

More of a concern, by our methodology, is the number of ill-conceived new funds launching and the number of funds scoring high returns of two or three times the already high returns of the S&P 500 off the bottom. These hot funds are now bringing in tons of money. The financial press, never learning from the errors of the past and always focused on what people want to read about, not what they should read about, is featuring these new fund geniuses as having the hot hands for today's markets. This of course is how 1999 was before the crash in hot stocks: dozens of funds up 100%+ in a year, new funds with trendy strategies, and investors that could not get enough.

We're not quite at that level of pure speculative stock market froth, but there are enough signs (besides triple-digit fund returns over one year) to be wary. One hot new ETF family has brought in tens of billions on future wonder stories that include many companies with zero earnings and a crypto coin fascination. There will be a new ETF that invests in stocks popular in online chat rooms. There is the continuing absurdity of GameStop speculation. Tesla bought $1.5 billion in Bitcoin and then touted the move, juicing Bitcoin and earning a quick near-billion. A dead-end software company that has largely missed out on the last decade in software growth and an old bubble favorite from 2000, Microstrategy, decided to put all its cash in Bitcoin, then do two large convertible bond offerings paying almost nothing in interest to raise cash to buy more Bitcoin — in effect, converting to a de facto Bitcoin fund. This is the 2021 equivalent of 1999's 'add dot-com to your name and watch your stock go up' business strategy. Nobody seems to wonder what will happen to the company if Bitcoin tanks.

If it is not now the equivalent of March 2000, it is certainly mid to late 1999 and it is time to cut back before the music stops. We can't do much, for tax reasons, as our buys from the short-lived crash last year will soon become long-term gains.

One opportunity we wanted to take is to cut back on inflation-protected bonds, which have done very well from the crash lows of 2020, when inflation looked like a far-off land. Pricing was finally good in this area last year, so we jumped in and exited from almost all other bond funds — except for emerging market debt, which we added for some upside. As it turned out, risky bonds and inflation-adjusted bonds did well, so this worked out on both fronts.

Interest rates are now back up fairly significantly, considering how low they were recently, hurting regular bond funds. Inflation-adjusted bonds have done well, as they do when fears of inflation are rising. Unfortunately this cuts into future returns, because inflation now has to be above 2.25% for inflation-adjusted bonds to beat regular government bonds. Could happen, but the potential was much better when inflation expectations were around 0.6% last year. Plus, inflation-adjusted bonds won't do well if we get another stock crash, unless it is a crash based on rising inflation fears, which is possible in the shorter run. Typically, regular government bonds do the best.

The bull case for stocks from these levels is that we're on the cusp of an economic boom, fueled by those desperate to get out of the house and spend all the freely distributed trillions in government money. This may very well be, but stocks are already pricing this in and could just as easily fall.

Trade Alert

We placed a few small trades at the end of February in our model portfolios.

Conservative Portfolio

We added a 5% stake in VanEck Vectors Pharma. (PPH) as its relative safety and low valuations should keep this fund afloat in even moderately down markets.

We added a 10% position in an oldy but goody, Vanguard Extended Duration Treasury (EDV), to take advantage of the recent bump up in rates, hoping for some downside protection in the next crash. This is a very risky fund in the short run if rates keep going up. Long-term, much higher rates don't seem possible as there is just too much debt that needs low rates. The only real question is the rate of inflation. Lowish rates of under 3% on 10-year government bonds should be here to stay, with plenty of short-term volatility.

We sold our 26% stake in Schwab US TIPS (SCHP) because prices had gone too high, leaving little room for gains without truly massive sustained inflation of maybe 3—6% a year. Possible, but considering how easy it would be for the Fed to stop inflation these days, unlikely. There is a risk of the government running 3—4% inflation as the best way out of this debt mess, but even then TIPs funds won't do that well in the long run from here.

We added (FXE) at 10%, just to have something with some direct upside if the US dollar continues to fall. If foreign bonds paid much and didn't also face rising rate issues, we would not use this fund and would instead go with a foreign bond fund. There is also risk here that the rest of the world doesn't get the vaccine out as fast as we do, and that our economy is off to the races first.

We also added Vanguard Long-Term Bond Index ETF (BLV) to benefit from higher rates, though again there is a risk of losses as rates head upwards on fears of a booming economy and inflation.

We sold iShares JP Morgan Em. Bond (LEMB) even though we really want foreign bond exposure. This fund has too much credit risk for a downturn and we wanted to book our gains since purchase, which were substantial compared to safer bonds which have been very weak lately. Ultimately, if rates keep climbing, all these risky bonds will start tanking as the spread between safe and risky yields is getting too close already. In other words, who would own this fund at a 4.2% yield if 10-year US bonds start paying 3% (currently 1.5%)? Bottom line: all bonds have downside from here if rates keep going up because the spread between high-risk and low-risk debt can't get much smaller, and typically will get much wider if the economy or markets slip again. That goes double for convertible bonds linked to high-flying tech stocks.

We also did a limited amount of rebalance trades, which included selling some Vanguard Energy (VDE) after a hot run, as well as Franklin FTSE South Korea (FLKR), another outperformer, and Franklin FTSE Germany (FLGR) and Homestead Value Fund (HOVLX). You can use your discretion on rebalancing to our official percentage allocations and in non-IRA accounts. You may want to wait until you have long-term capital gains on these winners, to sell without offsetting capital losses.

Aggressive Portfolio

We boosted VanEck Vectors Pharma. (PPH) from 6% to 9%, for similar reasons for adding it to the Conservative Portfolio.

We switched to a new 2% stake in (QID), which is an inverse 2x, and sold ProShares Short QQQ (PSQ), an inverse 1x, to generate losses to offset sales and to increase our short position in the Nasdaq, which has dwindled as the market has risen. Avoiding tech and growth stocks here is the best overall strategy, but we will continue to short this high-flying area of the market to help protect the rest of the portfolio. Unlike in 2000, you can't simply buy 5% government bonds and sit out a possible train wreck. Hopefully, this 4% effective short position in the Nasdaq will offset losses in the stock market. There is a possibility that our picks remain mostly flat and only tech slides. If the economy goes back into shutdown mode and tech booms anew and oil stocks tank, we're going to wish we didn't make this adjustment.

We took a new 10% stake in Vanguard Extended Duration Treasury (EDV) for the same reasons that we added it to the Conservative Portfolio.

We cut Schwab US TIPS (SCHP) from 9% to zero, for the same reasons as in our Conservative Portfolio.

We cut iShares JP Morgan Em. Bond (LEMB) from 8% to 4% for similar reasons as in the Conservative Portfolio. But we kept some of this stake because it is a riskier portfolio and can handle what could be a rough ride. Plus, we have shorts in the portfolio which may take the edge off, so to say, and wanted to limit short-term gains.

There were a few rebalance trades where we didn't change the official allocation but got the holdings back in line with our target allocations. This was limited, due to taxes. Vanguard Small-Cap Value (VBR) saw a small sell and ProShares Decline of Retail (EMTY) saw a buy. Frankly, we'd probably cut back on Vanguard Small-Cap Value (VBR) more aggressively if not for the tax implications and our desire to drag out the momentum gains that may continue.

We really thought these trades could be put off until a year after our buying during the COVID crash. Unfortunately there is just too much speculation going on these days not to make some changes. We'll probably make more in a few months' time, after our buys become long-term capital gains (which are taxed at lower rates than income). In an IRA or other tax-deferred account, this is not relevant. In general, our hunch that stocks are due for a pullback is not a good reason to realize gains at a significantly higher tax rate, so close to the one-year mark.

Stock Funds1mo %
Vanguard Energy (VDE)22.45%
Vanguard Small-Cap Value (VBR)8.79%
Homestead Value Fund (HOVLX)5.86%
[Benchmark] Vanguard 500 Index (VFINX)2.76%
Vanguard FTSE Europe (VGK)2.58%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.52%
Vanguard FTSE Developed Mkts. (VEA)2.43%
Franklin FTSE Germany (FLGR)1.97%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.65%
Franklin FTSE South Korea (FLKR)0.19%
Franklin FTSE China (FLCH)-0.58%
VanEck Vectors Pharma. (PPH)-0.90%
ProShares Decline of Retail (EMTY)-2.27%
Vanguard Utilities (VPU)-5.54%
Franklin FTSE Brazil (FLBR)-6.37%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)0.16%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.51%
iShares JP Morgan Em. Bond (LEMB)-2.39%

January 2021 Performance Review

February 7, 2021

In a month in which individual stocks entered what can only be described as a crazed bubble fueled by chat room manipulators, it was a calm month for bonds and stocks as a whole.

Our Conservative portfolio gained 0.36% and our Aggressive portfolio gained 0.20%. Benchmark Vanguard fund performances in January 2021 were as follows: Vanguard 500 Index Fund (VFINX), down 1.01%; Vanguard Total Bond Index (VBMFX), down 0.80%; Vanguard Developed Mkts Index (VTMGX), down 1.18%; Vanguard Emerging Mkts Index (VEIEX), up 2.93%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.00%. That is not a typo. The fund had a freakish zero return, correct to two decimal places. Maybe it was up or down .0001%.

In previous months we've seen big swings up and down in various fund categories, but recently things have calmed down somewhat. In January the biggest gainers were funds investing in energy or stocks in China, which were both up only around 5%. The worst category was Latin American funds, down just over 7%. We own funds in all three categories but were approximately flat for the month in our portfolios, which was a solid result relative to benchmarks. We hope it sets the tone for 2021.

It appears that all of the investment areas that have been lagging big-cap technology and growth are starting to catch up, while bigger U.S. stocks plateau at high levels. This has helped us in recent weeks, but it is leading to high valuations in many areas and might warrant a cut to our overall stock allocation. We've benefited from cutting way back on non-inflation adjusted bonds, as inflation-adjusted bonds are doing well now due to investors' fears of future inflation growth. This may lead us back to regular bond funds, which have had a lousy last few months and are becoming attractively priced (or relatively so, in a world in which nothing is particularly attractively priced).

You can't help but notice the massive speculative frenzy that seems to have moved from cryptocurrencies — now a bubble of over one trillion dollars — into businesses with questionable futures, such as mall-based video game retailer GameStop (GME) and movie chain operator AMC Entertainment (AMC). These stocks have been pumped but supposedly not dumped (at least, not by the new day traders as a group) in a likely ill-fated attempt to 'squeeze' professional short-sellers (and probably some ordinary gamblers) who have taken out massive short positions (selling stock they don't own and planning to buy back later at a lower price).

This is all mildly amusing; who doesn't want to see a small investor steal from a billionaire hedge fund manager? The scheme seems to be to profit by causing massive losses to the shorts having to cover their positions (buying shares back at a much higher price), allowing the day trader chat room mob to exit at higher prices. This last part is foggy.

While all this has made the shorting of likely business failures (the future Blockbusters and RadioShacks) a dangerous game, the mob's path to the exit seems questionable. New hedge funds may enter the trade, leaving the total short position unchanged as weaker hands exit (if funds exit at all, as some seem to be raising money to fight the chat roomers). There have also been reports of other hedge funds making hundreds of millions on the way up. Most recently, many of these so-called meme stocks (or stonks as they are known in chat room stock slang) have crashed back to earth. This raises the question — did hedge funds as a group make money on moves up and down, and were the actual manipulators crushed?

This new casinofication of investing (which frankly always had a casino element) is some sort of perfect storm brewing. Its causes include COVID-19 lockdowns, reduced opportunities for sports betting, and the increasing popularity of pocket casino investing at Robinhood, the millennials' app that encourages speculation by delivering 'free' trading with very unfree margin to small investor-gamblers.

Nothing is entirely new here, of course; just more, much more. In the late 1990s the SEC went after teenagers for pumping worthless penny stocks in chat rooms (on Yahoo and Raging Bull in those days, not Reddit) while Wall Street did its own questionable manipulating of hot dot-com IPOs.

The media and politicians seem to be siding with and promoting a David vs. Goliath story, while ignoring the probability of collapse when a company's prospects don't grow with its inflated stock price. (This is one problem Bitcoin gamblers don't have.) Then there is the possibility that illegal stock manipulation, long the preserve of big-time stock crooks, may have been carried out by other individuals who are finally getting their turn. While many large hedge funds are at least semi-crooked, such Ivan Boesky grade stock schemes are not the source of much of the gains.

The same media and politicians have largely ignored how Robinhood, the new day traders' favorite brokerage firm, chose a name for itself that implies the opposite of what it does, which is taking from the poor and giving to the rich. This includes profiting from bad price execution with kickbacks on 'free' trades (something all brokers do, but generally to a lesser extent), high margin costs, and lending short-sellers the very shares its customers want to boost, for sometimes huge lending fees (not shared with customers).

The media attention and the pending investigations seem to be about mysterious dark forces supposedly asking Robinhood to freeze trading in order to help the shorts. This is about as likely to be true as all the other mysterious global big-money conspiracies to be found on the internet. To be fair to Robinhood, they are responsible for the new zero commission world we all live in, which is a good thing, if you are mindful of the pitfalls.

If it seems to you that investing has become more about dodging conspiracy theories and investment bubbles, that's because it has. The last major boom in chat room stock bubbles didn't end well for the stock market in general. It fell just over 50%, while the hot stocks fell 80% or more, and the penny stocks went to zero, as all penny stocks eventually do.

There are two problems now. Unlike in 1999, you can't get 5% in safe bonds as an alternative to stocks. You have to make do with what will likely turn out to be a negative inflation-adjusted return. And while the biggest gains during a bubble are made just before it pops, we don't know if we are in the equivalent of early 1999 or late 1999. There is a fairly feasible story that we may be in for a post WW2-grade boom when COVID-19 restrictions dissipate that could drive stocks even higher.

Stock Funds1mo %
Franklin FTSE China (FLCH)8.43%
Vanguard Energy (VDE)4.96%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)2.93%
VanEck Vectors Pharma. (PPH)2.92%
Franklin FTSE South Korea (FLKR)2.18%
Vanguard Small-Cap Value (VBR)2.04%
Vanguard FTSE Developed Mkts. (VEA)-0.72%
ProShares Short QQQ (PSQ)-0.76%
Vanguard Value Index (VTV)-0.79%
Vanguard FTSE Europe (VGK)-0.90%
[Benchmark] Vanguard 500 Index (VFINX)-1.01%
Vanguard Utilities (VPU)-1.04%
Homestead Value Fund (HOVLX)-1.06%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-1.18%
Franklin FTSE Germany (FLGR)-1.18%
Franklin FTSE Brazil (FLBR)-7.46%
ProShares Decline of Retail (EMTY)-12.48%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)0.47%
Schwab US TIPS (SCHP)0.29%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.80%
iShares JP Morgan Em. Bond (LEMB)-1.06%

December 2020 Performance Review

January 6, 2021

What a year. The market doesn't typically (as in basically never) drop as far as it did early this year only to gain back the losses and end the year with gains.

In one of few months of the year we were proud of, in December our Conservative portfolio gained 3.34% and our Aggressive portfolio gained 3.86%. Benchmark Vanguard funds for December 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 3.85%; Vanguard Total Bond Index (VBMFX), up 0.15%; Vanguard Developed Mkts Index (VTMGX), up 5.81%; Vanguard Emerging Mkts Index (VEIEX), up 5.89%; and Vanguard Star Fund (VGSTX), a total globally balanced portfolio, up 3.62%.

Usually such slides take longer to drop and even longer to fully recover. This is the fastest recovery to new highs since the 1990 slide, which was only down 20%—not the nearly 40% we just saw. The closest parallel was the 1987 market with a short 30%+ bear market featuring a one day crash of 20% but with a positive year overall for stocks — though new highs took more than a year.

But then usually the Federal Reserve doesn't create trillions of dollars of new money to support panicked debt markets and the government doesn't send checks out to basically every American and incur trillions in deficit spending. It almost seems that Great Depressions are a thing of the past, like high inflation, or even short-term interest rates above 2%. All in, the total US market actually picked up about $6 trillion in total value for the year to a record of roughly 185% of the US GDP of $22 trillion, or $40 trillion.

How did we create $6 trillion in market value in a Covid economy? Well, 10% of that figure is basically due to the performance of Tesla (TSLA) alone—a bubble in a bubble. Beyond that, the Federal Reserve created around $3.2 trillion in new money and the federal government incurred about the same amount in pure deficit spending, largely financed by said Fed and global investors. We're not alone — other major economies are doing basically the same thing.

As much new money was created from the 2008 crash to last year in only about four months this year. This isn't an anti-Fed rant—if they can stop a depression and not cause massive inflation they are doing yeoman's work even if the end game is looking more and more like MMT or Modern Monetary Theory, in which the Fed basically says, "F it, we're never shrinking this balance sheet; in fact, the government doesn't owe us any interest either on these bonds we purchased with new money—we waive it." The bigger worry is how we pay for the stimulus spending: the $3.2 trillion in deficit spending this year is about 10 times last year's (pre-Covid) corporate tax take by the US Treasury. The government only takes in about $1.8 billion in income taxes per year, which means that we're not paying it off with tax revenues. Perversely, nobody seems to be as angry like they were in 2009 when the US borrowed half as much to fight the last economic crisis.

For the year our Conservative portfolio was up a pretty solid 10.4%. Because bonds were hit hard in the slide, we were down just over 20% peak to bottom, which can be compared to the S&P 500 sliding around 34% (the Dow and many foreign markets where down more). The S&P 500 with dividends as measured by VFINX was up an amazing 18.36% for 2020 (thanks mostly to tech and growth stocks). Our Vanguard Value Index was up just 2.28% for the year. That is a growth-to-value stock gap of 1999 proportions. We know where that went for growth stocks in 2000 of course—it was eventually over 50% down. We moved our Vanguard Growth ETF Vanguard Growth ETF (VUG) too soon—the fund delivered 40.22% for the year. Amazing. Our Aggressive portfolio had a terrible year, up only 4.9%, which of course seems good in a recession year until you look at the stock market. We didn't even miss as much downside as we did in all the past bear markets because bonds tanked as well (briefly) and the quick rebound in stocks wiped out our shorts, which were in the wrong areas to boot. Our 25% slide top to bottom in our Aggressive Portfolio wasn't enough downside protection in the absence of big upside here, frankly.

Until the end of the year we were lagging with a too low-risk portfolio that was too light on US growth stocks. We were prepared for the recession and a 50% stock slide that never came, but certainly not for a recession with record stock highs. Near the end of the year, our holdings picked up as investors starting piling into laggards and the US dollar started to slide harder. Ideally for our portfolios vs the S&P 500, we'll get some sort of 2000 crash 2.0 in which tech slides and foreign and value does relatively alright. This is likely wishful thinking in a Covid- stimulus-driven zero rate market.

In December, momentum was building in some areas that have way underperformed but are now leading—this is largely why our returns are coming back. Latin American funds, still down over 15% for the year, were up 11.29% for the month. Small cap value funds , barely positive on the year with a 4% return, were up 7.41% for the month. Foreign stocks and energy stocks also led the charge. The weakest areas were safer bonds with little to no credit risk, up around a half of a percent in December. Inflation-protected bonds did well as inflation fears continued to boost their price, which means that if inflation comes in lower than 2% in coming years, returns will be worse than the already-likely-to-be-poor returners because of low rates on regular treasury bonds. We may have to exit or cut back here but—and this is the dilemma that is pushing stocks ever higher—what to buy? Certainly not tech stocks, which just did a 56% year and a 7%+ month. It is mesmerizing how this area went from completely dominant in the late 2000s to a crash to mostly lagging after the value boom of the mid 2000s fizzled—now, they are once again at the top of the long-term charts.

Our hottest funds last month were Franklin FTSE South Korea (FLKR), up 13.58%, and Franklin FTSE Brazil (FLBR), up 12.33%. South Korea is clearly doing well fighting Covid, but the other, out of favor after a terrible decade (which followed an amazing decade), not so much. It almost had to go up. In bonds, all of our funds beat the bond index last month because rising risk tolerance lifted iShares JP Morgan Em. Bond (LEMB) 3.59%, while our safe inflation-protected bonds benefited from rising inflation fears, which boosts prices even with no change in actual interest rates. Our bond portfolio is now at risk of declines should there be another slide in the economy typically causing renewed fears of deflation.

Falling inflation expectations would hit our inflation indexed bond funds harder than regular government bond funds which benefit from falling rates and inflation. Our emerging market bond fund has credit risk and performs poorly in a downturn, though had the potential to do well as it has with renewed hunting for yield by investors.

There are two main possible future scenarios from here, each of which has wildly differing outcomes.

One is a return to normalcy, in which is that the virus is kicked out the door by vaccines and by an increasing percentage of people who receive immunity the risky and old fashioned way—by catching it. Under this scenario, everybody will be so gaga to get out and do stuff with trillions of stimulus dollars floating around and negative interest rates, and we will be off to the races (until the bills come due years later). A boom and an even bigger bubble!

Another is that we don't get a handle on the virus because we don't get to high levels of immunity fast enough, and we never fully get out of semi-shutdown mode, and those with previous immunity from vaccines or infection lose slowly lose immunity.. In this world, bailouts will eventually no longer be affordable, as the lack of proper targeting, waste, and outright fraud from previous spending catches up with us. Crash! 50%+ down!

Then there is sort of the default, in which nothing changes and we earn pretty paltry dividends. The alternative is negative inflation-adjusted returns from cash and bonds…


Stock Funds1mo %
Franklin FTSE South Korea (FLKR)13.58%
Franklin FTSE Brazil (FLBR)12.33%
Vanguard Small-Cap Value (VBR)6.80%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)5.89%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.81%
Vanguard FTSE Developed Mkts. (VEA)5.63%
Vanguard Energy (VDE)5.30%
Vanguard FTSE Europe (VGK)5.02%
Franklin FTSE Germany (FLGR)3.98%
[Benchmark] Vanguard 500 Index (VFINX)3.85%
Vanguard Value Index (VTV)3.50%
Homestead Value Fund (HOVLX)2.77%
VanEck Vectors Pharma. (PPH)2.20%
Franklin FTSE China (FLCH)2.01%
Vanguard Utilities (VPU)0.91%
ProShares Decline of Retail (EMTY)-3.44%
ProShares Short QQQ (PSQ)-4.88%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)3.59%
Schwab US TIPS (SCHP)1.25%
Vanguard S/T Infl. Protect. (VTIP)0.97%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.15%

November 2020 Performance Review

December 4, 2020

So much for the election causing trouble for the market. It was a good month all around for basically everything, with over a 10% rise in the S&P 500—and that was on the low end of global stocks. The news of multiple COVID vaccines saving us from perpetual shutdowns is likely a big part of the excitement. As discussed here recently, the stock market is in some form of a bubble, and perhaps investors just wanted to get this election hysteria out of the way to get back to the business of growth stock, speculating on the (reverse) Robinhood app, which ultimately will facilitate stealing from the poor and giving to the rich. Easy margin gambling from a phone is probably not going to create a world of millennial millionaires any more than day trading in the late 1990s did.

In such a can't-lose market, our Conservative portfolio gained 7.58% and our Aggressive portfolio gained 9.42%. Benchmark Vanguard funds for November 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 10.95%; Vanguard Total Bond Index (VBMFX), up 1.11%; Vanguard Developed Mkts Index (VTMGX), up 14.78%; Vanguard Emerging Mkts Index (VEIEX), up 8.22%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 9.72%.

Considering our Conservative portfolio in real money is currently only around 46% stock funds and our Aggressive portfolio about 68% stocks before deducting inverse ETFs in the Aggressive portfolio that take it down to effectively 62%-ish, this was a pretty good month relatively. The shift away from US big-cap tech to other areas abroad and to smaller-cap value stocks may be here in much the way the 2000 peak was really the end of a tech and growth stock bubble.

One area boosting our returns last month was energy, with Vanguard Energy (VDE) up 28% (yet still down from our purchase) as investors in this sector flip-flop between peak oil fears and a permanent reduction in air travel and the idea that the economy is going to boom from a stimulus and low rates driving up energy consumption. One thing is for sure: if Tesla really does deserve the recent $565 billion market cap, then oil companies, as well as many auto companies, need to start going out of business soon because everybody can't be worth their current valuations together.

Perversely, if Tesla is successful, boring old utilities companies could be the new energy companies. Fortunately, we own Vanguard Utilities (VPU) as well, though it was our least impressive stock fund last month—up an anemic 1.43% (after a decent run). Perhaps that is the seesaw—oil companies vs. electric utilities.

Foreign stocks were where the real action was, even though COVID and its resulting economic problems are fast becoming global again. Foreign stocks in general where up about 14% last month, with our newish holding Franklin FTSE Brazil (FLBR) up 24.06%, followed by Franklin FTSE South Korea (FLKR) up 18.38%. Our Vanguard Small-Cap Value (VBR) holding was up 17.42%, even more than larger-cap value stocks, which lifted Vanguard Value Index (VTV) up 12.76%.

To get an idea of how strong this growth-over-value boom has been recently, the 3-year annualized return on current holding Vanguard Value Index (VTV) is just 6.63% while the growth version Vanguard Growth ETF (VUG), a formerly popular ETF with us, is up 22.08% annualized. We clearly got out of growth (back in 2016-ish) too soon and missed the most exciting part of the bubble—the end. We bought Vanguard Growth ETF (VUG) in 2007 and owned several large-cap growth funds for years, but bailed for value too soon. We used to own the XLK tech ETF if you really want to cry about leaving a party too soon…

Bonds are a dangerous area with little room for capital gains and minimal yield, though significantly higher rates for long periods of time are almost equally unlikely as the world is now priced for low rates. The only real question is just how negative the returns will be adjusting for inflation—do we get 2% inflation on a 1% yield bond or 4% inflation on a 2% bond? Without much yield available, our only risky bond fund iShares JP Morgan Em. Bond (LEMB) had a good month, with a 4.82% gain, though much of this was just our dollar sinking relative to foreign currencies, a situation which appears to be accelerating. Much of the early 2000s' outperformance of foreign funds was based on a falling dollar as well.

It is really hard to just say stocks are overpriced because with negative inflation-adjusted low rates the moon is almost the limit. If you could borrow for 10 years at around 1%-3% (and many can) you can pretty much finance the debt cost with the cash flow from most successful corporations; in other words, if you borrowed a few billion dollars and bought a company, the chances of that not working out is slim. This is sort of like saying home prices are high now, but if you can get a loan at 2.75% and a tenant can cover all the costs of ownership including debt payments, is real estate expensive?

Playing the three bubbles works like this: imagine you had a $1M house with no loan that you plan on living in for 30+ years—you could borrow, say, $700k at maybe 2.75% and just buy a stock index fund and use the (low tax) dividends of 1.65%-ish plus some sales of maybe 3.25% of capital each year (until stock dividends grow to exceed the entire fixed mortgage payment) to finance the entire (often deductible) mortgage payment.

The only way you won't own a large portfolio worth millions in 30 years, paid for by a bank, is if you have to move or sell stocks after a drop or we get deflation in everything but your fixed mortgage payments. No wonder the Fed is printing money like a drunken sailor who somehow got a job printing money without a solid background in monetary policy in practice and theory.

How it all goes down from this very rational stock, bond, and real estate bubble is either rates go higher (not very likely) or simply the fear of losing 25%-75% fast in stocks takes over and everybody wants out (more likely) or the earnings (or rent in the real estate example) start to go down over time or deflate—the real depression scenario we've thus far avoided in 2008 and 2020.

So far the Fed seems ready to create as much money as possible to prevent that from happening. Maybe it will work with stocks and bonds, but how do you create enough money to rationalize paying ever-higher rents in a city with falling wages and occupancy levels without massive inflation? Stocks and bonds are easy to sell fast, so the panic button crash is more likely than in real estate, but real estate earnings are more at risk than stock earnings in this pandemic economic reshuffle.

Perhaps this bubble is really just money going places to not get watered down by the new money being created. Are we that far off from a (perhaps utopian) future where the government just creates money each month and distributes it to everyone to spend from their homes on goods and services from perpetually profitable companies that are so efficient we never get inflation, even with most workers on their sofas? If not now, perhaps with a robot workforce that can always produce more to meet demand. If all we buy is digital content, do old theories about supply and demand and prices even matter?

Stock Funds1mo %
Vanguard Energy (VDE)28.04%
Franklin FTSE Brazil (FLBR)24.06%
Franklin FTSE South Korea (FLKR)18.38%
Vanguard Small-Cap Value (VBR)17.42%
Franklin FTSE Germany (FLGR)16.74%
Vanguard FTSE Europe (VGK)16.39%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)14.78%
Vanguard FTSE Developed Mkts. (VEA)14.30%
Homestead Value Fund (HOVLX)13.10%
Vanguard Value Index (VTV)12.76%
[Benchmark] Vanguard 500 Index (VFINX)10.95%
VanEck Vectors Pharma. (PPH)10.41%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)8.22%
Franklin FTSE China (FLCH)2.89%
Vanguard Utilities (VPU)1.43%
ProShares Short QQQ (PSQ)-10.57%
ProShares Decline of Retail (EMTY)-15.18%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)4.82%
[Benchmark] Vanguard Total Bond Index (VBMFX)1.11%
Schwab US TIPS (SCHP)1.10%
Vanguard S/T Infl. Protect. (VTIP)0.59%

October 2020 Performance Review

November 6, 2020

In the three months to the end of October, the market was slightly down. Historically (almost 9 times out of 10), this correlates very well with the incumbent party losing the White House. This sort of makes gut sense: if stocks are dropping, there may be issues in the economy, and voters seek change when the economy is weak. With Biden on the edge of a win, you can chalk up another success for stocks predicting the outcome of elections. While not scientific, it's probably a better indicator than any number of expert predictions or even polling, in some cases. For the record, Hillary Clinton was leading in the polls in 2016, but the stock market was down before the election—and we all know about that surprise turnout. October was weak for both stocks and bonds.

Our Conservative portfolio declined 1.71% , and our Aggressive portfolio declined 1.19%. Benchmark Vanguard funds for October 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 2.66%; Vanguard Total Bond Index (VBMFX), down 0.61%; Vanguard Developed Mkts Index (VTMGX), down 3.73%; Vanguard Emerging Mkts Index (VEIEX), up 1.94%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 0.96%.

We don't want to over-analyze political correlations with stocks, but some goings-on are worth noting, especially since the stock market took a strange turn to the upside in early November, even given the oddities of this election developing results.

As for the three-month market indicator being right again, if any year would have made this indicator worthless, this was it, given the wild gyrations from pandemic shutdowns and massive stimulus programs by the White House and Federal Reserve. The recent huge climb from the abyss to new records (at least for larger cap growth stocks) was probably due for a fall back anyway.

In the days right before the election and during the election on November 3, the market started to take off—presumably on the assumption that Biden would win and that with Congress and the Senate going blue all sorts of massive stimulus programs would be passed. On top of massive Federal reserve support, stocks seem to like that. Note that the market doesn't really care much about 10 to 20 years down the road when such programs have to be paid for, or maybe the market figures we'll be inflating our way out of this mess and that could also be good for stocks, especially companies with debt.

It appears Biden is winning by only a squeaker and the Democrats seemed to have lost the chance to gain real power though the Senate, even losing seats in the House. Remarkably, the stock market took this as a great thing because it basically means all Trump-era policy is locked in place and we won't see a truly massive stimulus (just a massive one by, say, 2009 standards). This means low corporate taxes as well as low income taxes for all brackets are here to stay, at least until some expire years from now. It doesn't seem to bother anyone that this is a long-term disaster, financially speaking, with no major spending cuts or offsetting tax increases. Interest rates are heading back down, perhaps because without the truly massive spending plan that was being hatched by Democrats there is ample demand to buy just a few trillion a year in extra borrowing.

But if the market likes a Biden win, with our without full power, then it would have liked a Trump win losing power in the Senate as well. What about a Trump win with full control of both houses? Maybe the market just wanted to go up because really we are in a speculative bubble now, and without major riots in the streets or double-digit unemployment the drift is up, up, and away. This is how crashes happen.

In our portfolios, our only upside (not including short funds) last month was in small cap stocks, utilities with newly added Vanguard Utilities (VPU) up 4.89%, and—of all places—China, with Franklin FTSE China (FLCH) up 5.01%. Vanguard Small-Cap Value (VBR) gained 3.14%. Perhaps the great turnaround after years of large cap growth outperformance is upon us. With all the momentum and Covid economic benefits to big tech, this could be too soon, but then stocks tend to move before reality catches up.

We had some fairly large losses abroad as a resurgence in Covid cases leads to new lockdowns. Franklin FTSE Germany (FLGR) was down 10.28% as the formerly reasonably successful Covid fighter slipped. Europe in general was weak, with Vanguard FTSE Europe (VGK) down 5.42%. It is possible our political stalemate and slow grind to economic disaster will start hurting the dollar again and boosting foreign holdings, but with trouble abroad this may not materialize. All of our bond funds were down, but by less than 1%.

Bottom line: stocks seem to love low interest rates (actually negative adjusting for recent inflation in many cases) and huge deficit spending and couldn't care less about the longer-term problems we're creating. This could all be very wishful thinking by investors not considering the risks of political gridlock going into what could be a very dicey winter with the economy and Covid. Perhaps we did stumble into the best possible situation. Historically, stocks do best with a Democrat in the White House and 10 of the last 11 recessions happened with a Republican as president. You have to go to the 1800s to find a Republican who didn't have a recession in their first term. These patterns could be coincidences and don't seem to match the generally pro-business policies from Republicans.

Stock Funds1mo %
Franklin FTSE China (FLCH)5.01%
Vanguard Utilities (VPU)4.89%
Vanguard Small-Cap Value (VBR)3.14%
ProShares Short QQQ (PSQ)2.36%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)1.94%
Franklin FTSE South Korea (FLKR)-0.62%
ProShares Decline of Retail (EMTY)-1.12%
Homestead Value Fund (HOVLX)-1.25%
Vanguard Value Index (VTV)-1.82%
[Benchmark] Vanguard 500 Index (VFINX)-2.66%
Franklin FTSE Brazil (FLBR)-3.25%
Vanguard Energy (VDE)-3.47%
Vanguard FTSE Developed Mkts. (VEA)-3.55%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.73%
VanEck Vectors Pharma. (PPH)-4.86%
Vanguard FTSE Europe (VGK)-5.42%
Franklin FTSE Germany (FLGR)-10.28%
Bond Funds1mo %
Vanguard S/T Infl. Protect. (VTIP)-0.20%
iShares JP Morgan Em. Bond (LEMB)-0.38%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.61%
Schwab US TIPS (SCHP)-0.65%

September 2020 Performance Review

October 2, 2020

Recurring COVID economic fears on top of political uncertainly started to weigh on markets again. Until recently, markets had been acting as if the worst was well behind us, and it was just a question of how fast the recovery was going to be.

Our Conservative portfolio declined 2.12% and our Aggressive portfolio declined 3.29%. Benchmark Vanguard fund performances for September 2020 were as follows: Vanguard 500 Index Fund (VFINX), down 3.80%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.08%; Vanguard Developed Markets Index Fund (VTMGX), down 2.01%; Vanguard Emerging Markets Stock Index (VEIEX), down 1.67%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 1.88%.

Our recent trades didn't help much as there was real weakness in many areas that have had the worst returns of the last decade or so, relative to US larger cap stocks. This includes small cap value, energy funds, and many emerging markets, notably newly-added Brazil Franklin FTSE Brazil ETF (FLBR). Basically, anything that was popular with investors about 10—15 years ago has had a terrible 10—15 years.

We've been adding these long-term underperformers recently and getting out of any remaining larger cap growth or tech-oriented funds. In hindsight we started this transition way too early. Energy was the only fund category down by double digits last month as oil prices weakened, as did expectations for any sort of demand recovery in the future. Our new 2020 pick Vanguard Energy (VDE) was down a whopping 14.77% in this environment. Even the dollar started to edge back, dragging on most foreign markets priced here in dollars.

The only real shining area in our portfolios is South Korea, which is booming, with a 45% return since we added it in April and a 2.42% rise last month. It wasn't enough to help our otherwise lackluster returns in this strange COVID market, where mostly U.S. tech stocks lead the way and are benefiting from the losses in the less digital economy. This issue is global, as most countries don't have our country's dominance in digital. In many ways they are more exposed to falling earnings due to COVID, even though many countries are doing a better job than us of managing the outbreak and the shutdowns.

There is a sad zero-sum game going on because of COVID. Entire industries, particularly those related to travel, are losing most of their revenues to the COVID winners. It is not even a zero-sum game, as the entire economy is smaller than it was at the beginning of the year. This is why some of these stock moves up, even with the winners, are overblown. The entire market cap should be down, along with GDP. The winners' stock prices are gaining more than the losers are losing, and it can't go on forever.

Stock Funds1mo %
Franklin FTSE South Korea ETF (FLKR)2.42%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-1.67%
Vanguard FTSE Developed Markets (VEA)-1.78%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.01%
Franklin FTSE China ETF (FLCH)-2.09%
Vanguard Value ETF (VTV)-2.24%
Franklin FTSE Germany ETF (FLGR)-2.82%
Homestead Value Fund (HOVLX)-2.87%
Vanguard FTSE Europe (VGK)-3.09%
VanEck Vectors Pharmaceutical (PPH)-3.66%
Vanguard Small-Cap Value (VBR)-3.73%
[Benchmark] Vanguard 500 Index (VFINX)-3.80%
Vanguard Energy (VDE)-14.77%
Bond Funds1mo %
[Benchmark] Vanguard Total Bond Index (VBMFX)0.08%
Vanguard Short Term Inflation Prote (VTIP)-0.18%
Schwab US TIPS (SCHP)-0.31%
iShares JP Morgan Em. Bond (LEMB)-1.09%


September 16, 2020

We placed a few trades in both our model portfolios late on Friday, September 11th. The relatively minor changes were primarily to shift us out of some areas that had been hot and to add some lagging stock categories.

The rebound in stocks from the crash levels earlier this year has been a little too fast and furious, even adjusting for the low interest rates—if you can ever really adjust for low interest rates! This issue is particularly a problem with U.S. technology stocks, which are rapidly getting expensive, even beyond what incredibly successful near monopolies can be worth with near zero interest rates.

In our Conservative portfolio, we added a 5% stake in Vanguard Utilities ETF (VPU), a previous holding that has lagged recently relative to the tech-fueled stock market and is now worth buying again given its yield of around 3.4%, which should be inflatable over time and is very attractive compared to bonds today. You could get a higher yield in energy stocks (which we still own), but these represent a riskier yield. Real estate fund dividends aren't as attractive either and are possibly the most at risk of serious trouble as we possibly approach a once-in-a-generation downward adjustment to rents—at least in cities. We also dumped our 5% stake in iShares Edge Quality Factor (QUAL) after a roughly 31% gain since April. Cash-rich and low-debt companies benefit from being well positioned to manage best in a Covid-troubled economy. This positioning also means lots of tech holdings, but we don't want that exposure right now.

Specifically, in the Aggressive portfolio, we added a Brazil ETF, Franklin FTSE Brazil ETF (FLBR) to be exact, for a 6% allocation and purchased an "oldie but goodie" Utility ETF Vanguard Utilities ETF (VPU) for a 5% stake. We cut back our BRIC (Brazil, Russia, India, China) ETF iShares MSCI BRIC (BKF) from 6% to 0%, because it is now cheaper to own the countries we want to be in directly, partially thanks to the newish, very low fee, single-country ETFs from Franklin.

We also cut back our stake in Schwab US TIPS (SCHP) from 14% to 9%, because inflation expectations are rising and inflation-adjusted bonds now need pretty high inflation just to break even with regular treasury bonds. Typically, these bonds are purchased when investors are not worried about inflation, as was the case a few months ago. In fact, too high an inflation expectation can accelerate losses in a stock market crash as investors start to think that deflation is more likely. Overall, the bond market is becoming increasingly dangerous with so much money being put in by investors despite corporate bonds barely yielding more than Government debt, even with a high default risk from Covid-related economic disruptions.

We also sold our now almost nonexistent stakes (from massive declines) in an inverse leveraged Nasdaq ETF and an inverse gold mining stock ETF. Basically, we only made money by shorting oil in recent years. The Nasdaq deserved some of the increase as the world moved even more toward a plugged in Internet-based world (sadly) thanks to Covid, but it could still fall from these high levels. We need a new fresh position (which will also decline if Tesla and the other big names climb to even more ridiculous levels) with less leverage, in case we get big rebounds on the way down.

Gold mining stocks should do what they have done over the last 30 years—which is to go nowhere—and gold itself is only going up because holding money and short-term bonds is a loser position now. Covid has sent the demand for jewelry down by almost half—all the excess production has been picked up by ETFs that own gold and other speculations (future supply …). The short-term risk here is too high, especially with negative inflation-adjusted interest rates and a new gold bubble forming. Buffett's Berkshire Hathaway just bought a stake in a gold mine—even though Buffett has been a long-time critic of gold as an investment—after selling off an airline at a loss that he had only recently added to—that is how weird a world we are in at the moment.

We added an inverse offline retailers ETF as a possible good hedge against a second slide in stocks brought on by a potential fall in Covid cases. The concept is a little strange as all the retailers in the fund sell online as well has have big retail footprints, but then they could be hit with the double whammy of lost retail traffic and trouble competing with the ever-growing Amazon and other online tech giants squeezing the smaller retailers selling online.

As ETF trading is now free at TD Ameritrade (where these model portfolios are traded with real money) and basically all the other major brokers, we did some small rebalancing trades just to get our allocations back to where we want in some positions, but avoided cutting back in other areas that are up in order to avoid having too much in short-term capital gains (relative to the losses in inverse funds realized with this trade). This includes Franklin FTSE South Korea (FLKR), up around 50% since bought in our Conservative portfolio in April. In general, you almost never want to realize short-term taxable gains as no trade is worth the extra tax bite unless you have losses or could have losses elsewhere to offset the gains. Use your own tax situation and account type (IRA or taxable) to judge how much rebalancing you should do or to decide if you should hold off on some sales until short-term gains become long-term gains.

One area with a risk of future underperformance for us here is if U.S. stocks keep going up and up, notably tech stocks. By having larger foreign stock allocations we are basically avoiding tech stocks as most foreign countries have few top tech companies. In the longer run, it really depends on how much of the global economies' profits are going to be sucked up by a handful of tech giants that are increasingly in the middle of everything (so much for disintermediation) before regulations or taxes change the game significantly for these giants.

The main case for increased stock prices is almost guaranteed negative real (inflation adjusted) interest rates for years. This means Central Bankers are targeting say 2% inflation yet manipulating interest rates to around zero (some of this is just massive bond buying by the public). Losing 1%—2% of your money every year with the potential for 10%—30% hits if rates go up fast is not an appealing investment and makes even the most expensive stock make sense over time. Imagine if we had a 10% guaranteed negative real interest rate, say 0% interest rates and 10% inflation, is there any price that Apple stock would lose money over 10 years relative to bonds? Apple can just charge 10% more each year for iPhones and their cut of app sales will inflate with everything else and they could increase their dividends by 10% a year with no real change in their business. Deflation is far worse for business, and the Fed knows it.

In targeting 2% inflation with negative interest rates, the Fed creates almost limitless upside to inflatable asset prices—yet still will have trouble getting real world inflation to 2% when considering things like rents and energy and food. It would be much safer for the markets and economy to just create money and give it to people to spend and slow the Fed debt buying with newly created money or 'quantitative easing', but as creating money to spend directly is the historical recipe for rampant inflation in various countries, Central Banks are naturally scared of that strategy, but creating money that flows into investment speculation could be even more dangerous. Does it really make sense for companies to borrow their way out of the Covid mess because rates are low instead of issuing stock?

In closing, any market that pushes up a Tesla wannabe (Nikola...are you kidding me with this name?) that smells like a penny stock scam on steroids to a market value greater than Ford with no real path to profitability is a sign of a dangerous market distorted by low rates and a Robinhood-trading-app-stock-gambling culture.

August 2020 Performance Review

September 8, 2020

The bubble forming in fast-growing tech stocks — notably the handful of tech near-monopolies increasingly driving the entire stock market's returns — started to burst in September, but for August it was smooth sailing for the trillion dollar-ish market cap crew. Most stocks are still below the pre-pandemic all-time highs, but some are way, way up, driving the indexes to new highs. Interest rates crept up, hurting bonds and foreign markets benefiting from a weakening U.S. dollar.

Our Conservative portfolio gained 2.60%, and our Aggressive portfolio gained 2.71%. Benchmark Vanguard funds for August 2020 were as follows: Vanguard 500 Index Fund (VFINX), up 7.18%; Vanguard Total Bond Market Index Fund (VBMFX), down 1.02%; Vanguard Developed Markets Index Fund (VTMGX), up 5.07%; Vanguard Emerging Markets Stock Index (VEIEX), up 2.26%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.72%.

With basically no larger cap tech stocks except for iShares Edge Quality Factor (QUAL) up 6.86% last month, our returns were supported by foreign stocks, which in general had a decent month largely thanks to a weak U.S. dollar. Inflation-adjusted TIPs bond funds did well relative to the bond market as inflation expectations picked up. If this keeps up, we may have to move to Utility stocks as a big expectation for inflation can lead to problems in the next crash and falling inflation expectations. iShares Edge Quality Factor  (QUAL) is on the short list to get sold here.

Much as they did in the late 1990s, larger cap growth stocks are dominating the market. Unlike the 1990s, other areas like value stocks and bonds are no real bargain. The S&P 500 was up 7.19% with dividends last month. This gain beat basically 100+ global fund categories except for Japan, U.S. large cap growth, and U.S. technology stocks, and consumer cyclical stocks. Of course, large cap growth and tech stocks are what is driving the S&P 500, so this is just more of the same.

The tech action is even pushing up funds you wouldn't expect to see on the tops for the month — like Convertible bond funds, enjoying a 28% one-year return. These funds often own lots of Tesla convertible bonds, which are basically trading like the stock, now that the stock price is well above the conversion price on the bond. Tesla stock recently did a 1-for-5 stock split and was worth about as much as all the other auto stocks combined — not bad for less than a 1% global market share of sales. One head scratcher among many is why the other auto stocks haven't tanked — if Tesla is the future, are we just going to be selling more high margin cars in the future such that the old car companies can keep their market caps? Somebody is going to lose big time.

While parallels can be drawn to early 2000 (which ended very badly for tech stock investors and the S&P 500 in general), there are several important differences:

  1.  Interest rates are just above 1%, not over 5%. It is not hard to finance this debt cost with earnings from a company if you did a company buyout with debt — or just took out a 30-year mortgage and used the cash to buy stocks.
  2. The earnings are largely real. Tesla and some others aside, the bulk of the big tech companies are big earners on today's eyeballs. They don't even need to grow users or come up with a revenue model.
  3. The margins are monopoly grade. Companies like Apple and Google can take a third of all money going to apps. A few weeks after a Congressional shakedown, both Apple and Google kicked off a game maker for billing consumers directly and not cutting in the two phone operating system giants for their usual cut . Amazon is not far off from having a piece of most online sales. Facebook is selling ads off everybody's social media content and not cutting in content creators.
  4. There may not be competition for many moons because possible competitors will get bought out or crushed. Google couldn't beat YouTube, so they bought it. Facebook bought Instagram. Somebody is probably going to buy TikTok.
  5. The Covid pandemic is creating a tech dystopia where we all live in our houses and live off the internet. This has been building slowly since the 1990s and accelerated with smart phones, but this could be the last breath of the bricks-and-mortar economy. Sad!


It is a golden era of tech, but this is not a 'this time it's different' point to rationalize trillion dollar market caps. The boom can still collapse just out of fear in investors who recently bought in with leverage, but also longer term because there is only so much profit a handful of companies can squeeze out of the economy before global governments start turning up the heat. This regulatory shakedown could take many forms, but higher taxes to help pay for the trillions in Covid economic support on top of already lofty government debt piles seems probable.

Stock Funds1mo %
[Benchmark] Vanguard 500 Index (VFINX)7.18%
FTSE Germany (FLGR)7.04%
iShares Edge Quality Factor (QUAL)6.86%
Franklin FTSE China (FLCH)6.46%
Homestead Value Fund (HOVLX)6.37%
Franklin FTSE South Korea (FLKR)5.61%
Vanguard FTSE Developed Markets (VEA)5.17%
[Benchmark] Vanguard Tax-Managed Intl. Adm. (VTMGX)5.07%
Vanguard Small-Cap ETF (VBR)4.63%
Vanguard FTSE Europe (VGK)4.31%
Vanguard Value ETF (VTV)4.18%
iShares MSCI BRIC Index (BKF)4.18%
VanEck Vectors Pharmaceutical (PPH)2.40%
[Benchmark] Vanguard Emerging Mkts (VEIEX)2.26%
Vanguard Energy (VDE)-0.62%
Direxion Gold Miners Bear 3X (JDST)-6.67%
Proshares Ultrashort QQQ (SQQQ)-28.21%
Bond Funds1mo %
Vanguard ST Inflation Protected (VTIP)1.11%
Schwab US TIPS (SCHP)0.91%
iSHARES JP Morgan Em Bond (LEMB)-0.07%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.02%

July 2020 Performance Review

August 4, 2020

With interest rates near zero and property owners facing potentially massive problems with occupancy and rent collection, stocks are becoming the only game in town. But it is an increasingly expensive game to play. The U.S. economy shrank by around 10% this past quarter, taking us back to the GDP levels of about five years ago after adjusting for inflation, but the stock market continues to rise to almost record highs. While it is common for stocks to move ahead of the economy, both down and up, there are no previous cases of GDP being this far below its all-time high but stocks near all-time highs.

Our Conservative portfolio gained 2.05% and our Aggressive portfolio gained 2.72%. Benchmark Vanguard funds performed as follows in July 2020: Vanguard 500 Index Fund (VFINX), up 5.64%; Vanguard Total Bond Market Index Fund (VBMFX), up 1.55%; Vanguard Developed Markets Index Fund (VTMGX), up 2.64%; Vanguard Emerging Markets Stock Index (VEIEX), up 8.38%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 4.39%.

Our strongest areas were emerging markets, notably China, with FRANKLIN FTSE CHINA (FLCH) up 9.46%. The now large-cap-tech-dominated S&P 500 did better than almost everything else worldwide, with particular weakness in energy stocks in our portfolios, as VANGUARD ENERGY (VDE) fell 4.19%. As for bonds, a falling dollar and a continued rebound in risky debt helped iSHARES JP MORGAN EM BOND (LEMB) climb 3.78%, while our safer bond fund VANGUARD ST INFLATION PROTECTED (VTIP) gained just 0.76%, which was only half the return of the overall bond market last month.

The stock market's total value is about double the new lower annual GDP of $19.4 trillion. This is a record level, in what is one of Warren Buffett's snapshot measures of valuation of a national stock market. This ratio of market value to GDP is lower in every other country.

The previous high for this ratio was about 150%, in 2000, followed by around 140% in 2007. In both cases, slides of roughly 50% in stock prices followed. The 2007—09 slide took the stock market down to around 90% of GDP, which would equate to maybe a 55% slide in the market from current levels — if the economy stops shrinking. But such a slide in stocks is a long shot, because during the last two crashes you could still earn a decent return in bonds, whereas today stocks are likely your only chance of positive inflation-adjusted returns. Such a drop would be more likely if rates were to climb fast hitting bond prices hard.

At this point the Federal Reserve isn't so much creating long-term future earnings growth so much as removing short-term downside. We saw this explicitly a few months ago when it started supporting bond prices across the board as investor panic selling began. This support is the main reason to own bonds at all, with the risk of a slide due either to interest rates going back up or corporate (and maybe state) defaults rising in a weak economy. The Fed has your back and will support prices, directly. It is doing much the same thing with stocks, indirectly for now, which is why a 1.75% yield in the S&P 500 — which could be cut in half or more at this rate of economic trouble — is not shabby at all, if you remove the risk of losing more than maybe 25% in the short run.

Imagine if the Fed said it would print money and buy stocks if they go down 25%, take them back to their old highs, then slowly sell. What would the correct price for stocks be? With 1% interest rates, perhaps double their current levels, as stock dividends grow (most of the time) and are taxed favorably.

The only reason NOT to own stocks, with the Fed covering your losses and downside risk, is opportunity cost: what could you have earned elsewhere? To do better somewhere else would require interest rates to rise, but the Fed has already said in essence that it will not let rates go up either. So you are back to stocks again. The Fed's behavior could cause inflation, which is bad for bonds and maybe for the U.S. dollar, but not necessarily bad for stocks or real estate. But other major countries are in this same boat unless they can avoid longer-term lockdowns and continuing monetary support. The real risk is still deflation, such as Japan experienced after its 1980s bubble. But with aggressive money creation, is that possible? Stagflation is more likely: higher inflation with slow economic growth.

Investors aren't buying into this market recovery, and really haven't since the 20% drop in stock prices in late 2018, which also rebounded quickly. Over the last couple of years, around $400 billion has departed stocks for bonds. These days investors are putting tens of billions into bonds each week, with near guaranteed low returns, and pulling as much out of stock funds. Normally this is a huge positive for future stock prices and a huge negative for bonds, but these are not normal times. Much of this is likely just rebalancing because stocks are climbing faster than bonds, and much of it is on autopilot in index funds these days. But there were signs of panic selling of stocks on the way down, and huge outflows from bonds (the highest on record, it seems) when they briefly tanked in March. True rebalancing would have seen money go into stocks and probably into bonds, and out of cash.

For reference, in 2000 everybody was gaga about U.S. stocks. There was about 20% more investor money in stocks relative to bonds and cash, and all the new money was going into U.S. stocks. This was the beginning of poor returns in stocks and very good returns in bonds. In fact stocks still haven't caught up with long-term Treasury bonds purchased in 2000, and might need another decade or more to do so. This highlights the problem with buying stocks at valuations near all-time highs.

The 20-year annualized return on the Vanguard 500 stock fund Vanguard 500 Index Fund (VFINX) is around 5.8%, but it is a whopping 7.7% for the Vanguard Long Term Treasury fund (VUSTX) — a huge difference over 20 years. The chance of stocks underperforming long-term Treasuries over the next 20 years is about zero, unless we go into a Japan-style bubble deflation period, which is possible. But for stocks to catch up will require a big spread over bond returns for years to come.

At this point, at best, sluggish earnings growth (inflation-adjusted, after tax) is pretty much going to be here for years. Even with a relatively fast return to semi-normalcy in the global economy, paying down the trillions of borrowed money will require some mix of tax increases and less borrowing by governments worldwide, which by itself should wipe out much of the already slow growth rates in recent years.

The bottom line is that stocks are not a good deal at these levels, but cash, bonds, and real estate are worse. Sharp drops in stock prices, even if not to historically good valuations, are opportunities to buy, but from all-time highs, future returns will be low.

Stock Funds1mo %
Bond Funds1mo %